What is an employer retirement plan?

What is an employer retirement plan?

An employer retirement plan is just what it sounds like: a plan set up by your employer to fund your retirement. Beyond that general similarity, however, employer plans can vary greatly. In some employer plans, the employer contributes all of the money and guarantees you a set amount of income during your retirement. On the other end of the spectrum, other types of plans might not require the employer to contribute anything-or even guarantee that there will be money in the plan when you need it.

There are many types of employer plans; two of the most common are defined-benefit plans and defined-contribution plans.

Defined-benefit plans promise a specific dollar amount to each participant beginning at retirement. The promised payment is usually based on a combination of factors, such as the employee's earnings and years of service to the company. Generally speaking, the employer is the one who contributes money to the plan. When people speak of "pensions," they are usually thinking of defined-benefit plans. These types of plans are becoming very rare indeed.

In a defined-contribution plan, there is no guarantee of money at retirement, and the employer does not bear the full burden of contributing to the plan. Rather, the employer establishes the framework of the plan so that you, the employee, can contribute some of your income to the plan. Sometimes, but not always, the employer contributes money to your account as well. Both you and the employer get tax breaks on whatever money you contribute, and the money grows in the plan tax deferred. That means you pay taxes on the money only when you withdraw it from the plan. The risk of defined-contribution plans is that they don't guarantee that there will be money in the account when you retire. If you manage the account well, and if luck is with you, your assets will grow in the account and be there when you retire. If you manage the account poorly, however, or if you have bad luck, you could end up with far less than you need-or nothing at all.

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